April 8 (Bloomberg) -- The Federal Reserve’s decision to give banks more time to comply with Volcker Rule standards for collateralized loan obligations won’t keep banks from being forced to take losses, according to the Loan Syndications and Trading Association.
Banks, which hold about $70 billion of the senior-most CLO notes, will be compelled to sell them into a declining market leading to material losses, the trade group for the loan industry said in a statement yesterday. The central bank needs to grandfather CLO notes issued prior to the publication of the final rule, which makes them immune to the requirements of the restriction, to avoid an impairment of the CLO market, the LSTA said.
The Fed announced plans to address banks’ complaints by issuing two one-year extensions to make their interest in CLOs conform with the trading restrictions adopted in December, according to a statement released yesterday. Banks are restricted by the Volcker Rule from investing in CLOs that purchase bonds.
“It is ironic that the Volcker Rule, which is designed to limit banks’ investments in risky assets, would force banks to realize billions of dollars of losses in a very safe investment, due to a fire sale,” Meredith Coffey, the LSTA’s Executive Vice President of Research & Analysis, said in the statement released by the trade group.
CLOs typically buy speculative-grade loans and package them into securities of varying risk and return, from AAA ratings down to B. The highest-rated portion is the largest part of a CLO and banks have traditionally been the biggest buyers of that portion. The lowest, known as the equity tranche, offers the biggest potential return and the greatest risk.
“This is not a solution to the problem of bank ownership of CLO tranches under Volcker,” David Preston, an analyst at Wells Fargo & Co., said in a report. “Banks still face a situation in which they may ultimately have to sell assets that are unlikely to pose credit risk.”
While it doesn’t appear that the deadline extension precludes additional regulatory relief for the banks, the danger is that they may view this as the last word, Preston said.
The Fed’s decision gives banks time “to get their house in order,” according to a report from Citigroup Inc. analysts Ratul Roy and Ryan Brauchler.
The $10.8 billion of CLO issuance last month was the most since May 2007. Last year, issuance had climbed to a six-year high of $82 billion. Previously, the Fed had given the banks until July 2015 to comply with the rules.
“Fed’s Volcker CLO extension makes more lenient bill unlikely,” Melissa Avstreigh, a Bloomberg Industries analyst, said in a note today.
The decision by regulators to give banks more time to divest obligations to comply with the Volcker Rule may halt momentum in Congress for a related bill that sought exemption of CLO debt securities from the rule, Avstreigh wrote.
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